What is an Escalation Clause and How Does it Work?

In a hot housing market, like we have in much of the United States, there are often house listings that get multiple offers. Multiple-offer situations can frustrate many buyers because they do not want to compete with other buyers or get in a bidding war. Some real estate agents will encourage their buyers to use an escalation clause to give them a better chance of getting their offer accepted. An escalation clause is a provision added to the contract that states a buyer’s offer will be a certain amount higher than any other offers up to a certain amount. For example: “This offer will be $500 higher than the next highest offer up to $280,000”. Escalation clauses are very popular in many areas but can cause a lot of problems for buyers and sellers. As a seller, I have many ways to deal with escalation clauses and ways to protect a seller if they are dealing with escalation clauses.

What is an escalation clause?

When creating an escalation clause, the buyer’s agent wants to get the buyer the house without paying too much money. In theory, the clause is great for the buyer because they can start with a low offer and go up only high enough to beat any other offers. Here are what most escalation clauses include:

The maximum price the buyers will offer

The increment the buyer’s offer will increase over any other offers

A requirement that the listing agent show the buyer’s agent the competing offer they had to beat.

Usually, the clause will say that the personal information of the competing offer can be blacked out so there are no privacy issues with showing one buyer another buyer’s offer.

What are some of the problems with using an escalation clause for the seller?

Escalation clauses can be great for buyers, but they can cause a lot of problems for the seller. I flips houses and represent sellers as a real estate agent. I have sold 22 of my own houses so far this year, and I deal with escalation clauses all the time. Here is why I do not like the clause as a seller:

The seller can leave money on the table because the buyer may be willing to pay more without an escalation clause.

In my opinion, there are still privacy issues with showing another buyer’s offer to other buyers without their permission.

If you let one buyer use an escalation clause, you should really let every buyer use one. That means the listing agent should inform all the buyers that made offers that one offer used an escalation clause and the other buyers can as well. Informing everyone should also get the seller more money but can cause other problems.

If you have multiple offers with escalation clauses, there can be confusion as to what the price should be. I will talk more about this soon.

I am an REO listing agent, which means I list foreclosures for banks. Almost every bank I work for will not accept a contract with an escalation clause because of these issues. They require the buyer to submit their best offer without any increases.

How can accepting an offer with an escalation clause cause serious problems?

One of the agents on my team recently ran into a huge problem with one of his listings. He had a listing where the seller received 7 offers. More than one offer had an escalation clause, and the offer with the highest max price in the escalation clause was accepted. After the offer was accepted, the buyer whose offer was the highest argued that the other escalation clause was not the offer price in the other offer. They argued that the listed price in the contract was the only price they had to beat, not the increased price in the other offer’s escalation clause. The difference in price for the seller was over $60,000. The seller and buyer have been arguing for weeks about how to handle the contract, and other issues have come up as well:

The buyer’s agent has argued that because the other offer was financed, their offer should not have to compete against it in the escalation clause because their offer was in cash.

The buyer’s agent has argued that because the other offer did not have proper proof of funds, it was an invalid offer, and they should not have to compete against it.

The buyer’s agent has argued that because the other offer had an appraisal contingency, it is not a valid offer because their offer did not.

As you can see, there are a lot of problems when an escalation clause is accepted, especially when there is another escalation clause. The title company cannot come up with a price either because there is no set price in the contract. They wanted an amendment signed by all parties that states exactly what the price is. The buyer will not agree to the higher price, and the seller will not agree to the lower price. This is still an ongoing problem, and hopefully it is resolved soon.

How can the seller take advantage of an escalation clause?

It appears that escalation clauses favor the buyer because they can get their offer accepted on a house at the lowest possible price. However, I think there are many ways that escalation clauses can help the seller as well. The first thing to remember about an offer with an escalation clause is it is just an offer. The buyer can ask for anything they want in an escalation clause, but the seller does not have to agree to it unless they accept and sign that offer. The buyer can ask the seller to show them other offers. They can also ask the seller to price their offer at $500 over any other offers, but the seller does not have to accept those terms. Here is what I do when I receive an escalation clause:

I never accept a contract with an escalation clause. I always counter the contract, removing the clause so that we do not have problems like the one I discussed with the agent on my team.

I never agree to show the buyer any other offers.

I never agree to a price that is $500 above another offer. I will counter the buyer with a specific price.

I can counter the buyer at any price I want because I am the seller, and I can sell my house on my terms. If the escalation clause says the buyer will pay up to $280,000 for a house, I know they are willing to pay that much and can counter them at $280,000 no matter what the other offers are. I could even counter them at $300,000 if their price is not high enough, or I could counter them a little lower if I think countering at their top dollar will scare them off.

As a seller, I like escalation clauses because I do not have to accept the terms of the clause, and the buyer tells me what their top dollar is. If the seller were simply to make an offer without the clause, they may not offer as much.

Should buyers use escalation clauses?

I also buy many houses (I have bought 24 so far this year), but I never use escalation clauses in my offers for the following reasons:

I am telling the seller what my top dollar is. I usually offer my top dollar in multiple-offer situations anyway, and I am fine paying that amount because I will still make my desired profit on a deal.

Many sellers and agents do not like escalation clauses. I mentioned that banks will not accept the clause, and many other sellers do not like them either. If I am trying to get a good deal on a house, I want to make friends with the seller and their agents, not make them upset.

Some sellers may actually miss the escalation clause and only look at my original offer price. I have seen this happen a few times where another offer was accepted because the agent or seller missed the clause that said the buyer would pay more than the offer price in the contract.

I have also heard that in some areas of the country, escalation clauses are the norm and everyone uses them. I would be careful using them as a buyer, but your real estate agent may be able to give you more information on how wise it is to use them in your area.

Conclusion

I do not like to use escalation clauses as a buyer, but if you know how to respond to an escalation clause as a seller, you can use it to your advantage. A seller does not have to accept the clause in the contract. They can counter whatever they want and respond however they want. I hope this article shed some light on escalation clauses, and if you have any comments or questions, leave them below.

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